Wednesday market update

When Ronald Reagan ran for President, there was 9% savings rate.

The bull market started in 1982. That means, that when the savings rate is again 9%, wait two years, and then a new bull market may be beginning.

The S&P 500 price to book ratio is not yet 1.0 like it was in 1980. So therefore, it appears that as the price to book goes down, savings go up, and then when everyone gives up, it's time to buy.

When you're at a cocktail party, if people can afford it in a few years and you mention stocks, people will look at you with contempt. Then it will be time to buy. That is, if the buyers have any money. But they will, since savings will continue to go up.

Selling was severe today. New lows for the NYSE shot up to 331 and 224 for the OTC, a sign the bulls are losing this battle.

Unable to hold the trend either within the wedge formation or breakout above the wedge, a break down has occurred, forcing the market to test the November lows where the next major support level rest.

I think until the government can put forth a clear strategy for dealing with the housing/banking crisis, it is clear investors are stepping back from the plate.

The sad fact is the economy is beginning to paint the picture of the risks of a deflationary spiral developing and since most investors have never experienced deflation it is not clearly understood.

A deflationary spiral is a situation where decreases in price lead to lower production, which in turn leads to lower wages and demand, which leads to further decreases in price. Since reductions in general price levels is called deflation, a deflationary spiral is when reductions in prices lead to a vicious circle, where a problem exacerbates its own cause.

The Great Depression was regarded as a deflationary spiral.

There are three self-reinforcing adverse cycles that are worsening- we should all understand them.

SOARING UNEMPLOYMENT CAN CREATE MORE JOB LOSSES

Some 3.6 million jobs have been lost since the downturn began over a year ago. The new stimulus package promises some 3 million jobs out of this bill, but the stock market is coming to realize that millions of jobs are likely to be lost in the coming quarters if the economy is still contracting.

With job losses (or underemployment) comes the evitable - a cut in consumer spending.

As this worsens businesses reduce their payrolls, sales keep falling fast and firms are forced to cut prices to sell their goods.

Any business with debt is finding it increasingly difficult to service the debt, especially if you have to keep cutting prices to move goods. Consequently, companies produce less and what follows are more job losses in a vicious circle.

GLOBAL CREDIT CRISIS DEEPENS

As loan defaults skyrocket financial institutions have no choice but to rein in lending and in the age of globalization, where loans are parceled out around the globe, the credit crisis is spreading globally.

For example, Japan’s economy is in the worst shape in 35 years as Japan’s leaders are powerless to prevent this economic meltdown. Projections are that Japan’s GDP will slip at an annualize rate of 9.6% from January through March. Anything close to 10% contraction is thought to be a depression.

This was a big factor in depressing US equities today as more and more investors realize just how serious this decline is affecting our trading partners.

The sad fact is this will only force businesses to cut back even further on spending, which in turn creates more credit problems.

As loan losses grow, banks are not able to stop their liabilities from exceeding their assets and they grow insolvent. Perhaps you’ve heard that some banks have become zombies, with their shingles out for business but unable to function, unable to loan. Citigroup and Bank of America are two prime examples.

I think the reason why the government has been reluctant to reveal details about their plan to deal with the banking crisis is they are trying to see how much private investments they can raise to address these issues before they reveal how much the government is going to have to pony up.

Naturally, private sources of capital are reluctant to lend given the sheer size of this problem, so we still don’t know how this card is going to play out or how much time it will take to break this cycle.

Estimates of capital still needed even with this stimulus bill, range from at least $600 billion to two trillion dollars to just get banks solvent again, much less lend again. Unless these losses are stunted or unless more capital is quickly found, the tightening credit spigot freezes ever more solid.

FORECLOSURES ADD TO THE SPIRAL

This is the heart of the problem and the government has not really addressed this issue to the satisfaction of the stock market.

It is estimated that 13.8 million are underwater on their homes. These people are locked in unable to refinance their homes. As prices continue to fall, their debt to equity ratios make people more vulnerable to foreclosures.

As people lose their jobs or become underemployed more homes become subject to defaults. It is estimated that some 21 million people are underemployed and this number keeps skyrocketing.

Consequently, more homes are being forced upon the market, with banks being forced to unload a steady supply of foreclosed homes, driving prices ever lower which is at the heart of this severe deflationary downward spiral.

NO GOOD SOLUTIONS

I think the stock market is telling us that it remains skeptical that such a severe downward spiral can be stopped any time soon, especially with a plan that is more designed for helping people cope with the recession/depression than a plan designed to fix what is truly ailing the economy.

In a sense, the government is telling us it has to help people deal with a potential depression as its first priority and hope over time that it can stop the bloodletting.

This isn’t what the stock market wants to hear as it is realizing the government can only do so much. It doesn’t have a solution that’s going to turn the economy around anytime soon.

It is going to take perhaps several stimulus packages in the next few years before we start to see growth again. This doesn’t give the bulls much hope here.

INVESTING

I want you to understand that my main mission is to help get you through this perfect financial storm with your capital intact. This isn’t an easy task given the uncertainty of this situation.

We have to make the right decisions here and use strict discipline to maneuver correctly through this massive bear market as the market is brutal to those who judge risk incorrectly.

Since the first of January the DOW has fallen 1,482 points or 16.4% and this with a government that has given the President the bill he asked for.

I want you to look at the weekly chart of the long term US government bond.

Notice that government bonds have formed a bottom at the weekly middle Bollinger Band line, with the weekly stochastics at %K 8 and %D 21 and are now starting to nest upward.

My point is that government bonds are poised to rally again. This chart suggests that a rebound in government bonds would mean a flight to safety out of equities into government bonds again.

This is another cautionary signal that the intra-markets have a set up for a possible break down through the November lows. Certainly we have to be on the watch for this as this is a risk that might prove very costly to ignore.

From a technical perspective, unable to break out above the wedge formation, the stock market has broken down through the wedge support. Consequently, the next support is at the November lows – and the DOW 30 is now only 103 points away from testing it. The Nasdaq and small caps have much further to fall.

We are not only testing the November lows but if you look at the long-term charts we are also beginning to test the lows of the last bear market in 2002 – at least for the DOW.

Testing and retesting is all about proving whether a major bottom has been established.

Looking at the government bond market on an intermediate term basis, poised to rally on a flight for safety and with crude oil poised to sell off on a deflationary scare and the deteriorating technicals for the stock market---investors need to be extremely careful here!